Some people may invest in stocks for quick returns, but that’s betting on stock prices going up in the short term. And you’ll notice soon enough that short-term price movements are unpredictable.
Instead of booking a quick profit, there’s a safer and more profitable way to go about investing–invest in quality businesses you want to own for a long time. Here are a few tips that will help to improve your long-term returns with reduced risk.
Growth and profitability
Focus on quality companies with a track record of long-term growth and profitability.
The Big Five Canadian banks have been around for a long time. The youngest of the five, Canadian Imperial Bank of Commerce (TSX:CM)(NYSE:CM), was established 55 years ago in 1961.
Although there have been some rough patches in its earnings per share (EPS) in the last two decades, CIBC has a trend of increasing its EPS. In the last 10 years the bank only had two years of negative EPS growth in 2008 and 2009 during and right after the last recession, which was triggered by the financial crisis.
Strong companies will eventually turn around. CIBC proved itself to be a strong company as its EPS recovered to pre-crisis level by 2013.
Does the company treat shareholders well?
Mature companies, such as CIBC, offer dividends to their shareholders. Naturally, these companies pay good dividends in good times. However, it’s more important to see how they treat shareholders during rough times.
During the last recession CIBC maintained its dividend (while some other companies slashed theirs). The bank started increasing its dividend again in 2011 when the business dynamics improved again.
Since 2011 CIBC’s dividend has increased 35%. If you had invested in CIBC at the end of 2011 when it showed improving fundamentals (signaled by a growing dividend), you would be sitting on annualized gains of 10.9% and a yield on cost of nearly 6.6%.
Are the dividends safe?
A dividend paid out from a lower payout ratio is generally safer than a dividend paid out from a higher payout ratio. Compare the payout ratio of a company you’re interested in with its peers in the same industry.
CIBC’s payout ratio is about 49%. Royal Bank of Canada’s payout ratio is 48.8%, Toronto-Dominion Bank’s is 45.4%, Bank of Nova Scotia’s is 50.2%, and Bank of Montreal’s is 47.3%.
TD has a lower payout ratio because it increases its dividend once a year, while the other four banks increase it at least semi-annually.
The banks’ payout ratios are approximately 50%. So, CIBC’s payout ratio aligns with that of its peers. Additionally, CIBC has paid a regular dividend since 1868. So, it’s unlikely that management would want to break that record.
Conclusion
By becoming a part-owner of quality businesses that show a trend of growth, you can benefit from the ownership as the businesses become more profitable over time.
Safe dividends increase the stability of your returns as you receive them year in and year out, no matter what the market does.
